The Small Business Myth

When the government tries to help small businesses, it hurts businesses (and taxpayers) of all sizes.

Who better embodies the American dream than a small-business owner? Independent, self-reliant, flexible, and hardworking, small-business owners, we are always told, are the cornerstone of economic growth and prosperity. That's why lawmakers are always pushing policies to help them prosper.

During recessions, small businesses are inevitably hailed as the key to recovery and showered with still more targeted programs. This latest recession is no exception.

In his State of the Union address this year, President Barack Obama announced that "jobs will be our number one focus in 2010, and we're going to start where most new jobs do, with small business." Since then he has proposed and signed a series of targeted tax breaks. The president also asked Congress recently to use $30 billion that had been set aside from the Troubled Asset Relief Program to start a new program providing loans and tax credits to small businesses.

These policies are based on a myth. It's not true that the key to boosting employment is to help small businesses, even though Washington's definition of the term is far more expansive than you might think. According the Small Business Administration, a small business is a firm with fewer than 500 employees—not just your average mom-and-pop shop. By this definition, 99.7 percent of all employer firms are small. Still, big companies—the ones that employ more than 500 workers—account for about half of the country's total employment. In the 1990s, as the McKinsey Global Institute economists James Manyika and Byron August recently explained in The Washington Post, large multinational corporations created jobs more rapidly than other companies, and they have been vital to employment in the subsequent decade as well. In other words, new jobs come from small and big businesses. If your goal is to boost jobs, it doesn't make sense to favor one over the other.

In any case, the effectiveness of the policies aimed at helping small firms is dubious. Consider the tax credit for new hires, a favorite of every administration. Obama wants to give enterprises of any size a $5,000 tax credit for each employee they add to their payroll this year. Startups launched in 2010 would be eligible for half of the tax credit. This is a bigger version of the $1,000 tax credit passed by Congress with the help of four Republican senators back in February.

These politicians rightly assume that lowering the cost of employment helps firms keep their current employees or hire new ones. They're wrong, however, to think that tax credits are the best way to reduce costs. A tax credit is useful only if you have a tax liability to use it against. If your business is slow, it is likely that your tax liability will be significantly reduced or even nonexistent. No customers means no need for additional employees, tax credit or not.

Direct or guaranteed loans to small businesses are another common approach. The idea here is to help small businesses get access to capital, allowing them to create jobs. With that in mind, the administration included $730 million in the stimulus bill to increase government guarantees for some Small Business Administration loans, thereby reducing lender risk, and to cover borrowers' fees up to $75,000 per loan. The government also took aggressive steps to boost bank liquidity, with up to $15 billion aimed at unfreezing the secondary credit market, where most commercial and small-business loans are made.

So far the efforts have been fruitless. These policies are based on the assumption that small businesses aren't borrowing money, investing, and hiring because risk-averse banks won't lend them the money. The reality is not as straightforward. Banks are more careful about lending money these days, and the credit market is certainly tighter. But the demand for credit has dropped dramatically. Borrowing money, investing, and increasing staff are things to do during good times, not bad.

Public policy uncertainties also tend to decrease business investment. The health care overhaul will bring new but still unknown obligations to insure employees; the Bush-era tax cuts are set to end next year, but their fate is unclear; legislation aimed at tackling climate change could raise businesses' energy costs. Meanwhile, as government spending increases, so do the chances of more taxes in the future. As a result, companies are freezing new hires, cutting benefits, and delaying expansion plans.

Which raises the question: Are Obama's tax policies doing more to help small businesses or to hurt them? According to the National Federation of Independent Business, the largest small business association in the country, two-thirds of small businesses report their business income through the personal income tax system. Letting the Bush tax cuts expire means that these business owners will see their tax bill increase and will have less money to spend on hiring or keeping employees. Why give with one hand to take back with the other?

Richard Fisher, president and CEO of the Federal Reserve Bank of Dallas, agrees. In a July speech, he said: "Businesses and consumers are being confronted with so many potential changes in the taxes and regulations that govern their behavior that they are uncertain about how to proceed downfield. Awaiting clearer signals from the referees that are the nation's fiscal authorities and regulators, they have gone into a defensive crouch." Federal Reserve data confirm this impression. Today businesses are sitting on $1.8 trillion in capital instead of investing it. From 2008 to 2009, small-business capital expenditures plummeted by $63.6 billion (see chart), while owners' personal investments in their businesses fell by $2.5 billion following a decrease of $9.2 billion the previous year.

Neither small nor large businesses can flourish in an environment of anxiety about government intrusions and burdens. By reaching into virtually every sector of economic life and by picking winners and losers, the government is injecting uncertainty into the marketplace and making it harder for the economy to recover. To start helping American business, Obama needs to stop trying to help.

Contributing Editor Veronique de Rugy (vderugy@gmu.edu) is a senior research fellow at the Mercatus Center at George Mason University andreason's economics columnist.

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80 responses to “The Small Business Myth”

Barack Obama was a lawyer, and lawyers benefit from mountains of confusing government regulation, so don’t expect clarity from this administration.

Additionally, as government continues to swell, we are going to find more policymakers in power who have managed to live their entire lives in the safe bubbles of the public sector or academia, where wealth creation is a thing that has been only witnessed firsthand in lab exercises. They cannot fathom economic growth absent the machinations of the state.

I am just guessing, but it’s not that far out. It’s not like someone starts a successful business and then one day up and abandons it to go work at Cato. Ideopanzering is a full-time job, and it’s mainly for academics — sociologists, poli-sci majors, and economists. Libertarian institutions aren’t any different from others in that regard.

Oh Boy, another special program for special people which will probably not help anyone but the scammers who will be attracted to this program. The scammers being both in government running it and outside of government demanding their share and both will get rich off the taxpayers of today and the debtor taxpayers of tomorrow who must service this mess.

What would actually help people would be a simplification and reduction of taxes since then people could concentrate on running their own lives instead of jumping through tax loophole

A tax credit is useful only if you have a tax liability to use it against. If your business is slow, it is likely that your tax liability will be significantly reduced or even nonexistent. No customers means no need for additional employees, tax credit or not.

Not only that, but many small businesses are S-corps, and don’t even pay taxes.

Borrowing money, investing, and increasing staff are things to do during good times, not bad.

Duh. There was an article in my local paper, where they interviewed a couple small, local, community banks. The problem isn’t having money to loan, the banks are well capitalized, the problem is, nobody wants to borrow. Loans have to be repaid, eventually. If the government wants to give me money to hire new employees, I’m sure I could find some work for them digging ditches, and refilling them, in my backyard. Of course, I would take a cut of that money.

Small businesses want to expand, the problem is, you can’t expand if you have no new orders. I’m not aware of businesses that actually borrow money to hire employees. Don’t they generally borrow to buy equipment, property and advertising?

These policies are based on the assumption that small businesses aren’t borrowing money, investing, and hiring because risk-averse banks won’t lend them the money.

Which means the assumptions are based on ignorance of economics.

The reality is not as straightforward […]the demand for credit has dropped dramatically. Borrowing money, investing, and increasing staff are things to do during good times, not bad.

The reason is because of the consumption of capital that happened during the boom (consumption of capital can mean foregoing replacement or repair of machinery, or capital expenditures on unprofitable ventures, like [ta-da!] housing and commercial real estate.) Borrowing is done not to replace consumed capital or as cash flow, but for capital expansion when demand increases. If demand drops, demand for capital should also drop.

Businesses that use borrowed money to make payroll are simply accelerating their death process.

[Well, in all fairness, a short-term line of credit can be helpful for meeting payroll.]

And banks treat this type of loan …. differently… like borrowing to pay off a credit card for instance, another iffy move. Whorish rates of interest for starters, and stiff collateral requirements. Because they know, this is often the first sign of bid’ness troubles ahead.

Well, my business did try to get an expansion loan this year only to be told “we don’t have any money to loan!!” The hits the banks took on residental and commercial loans in 2009 along with the additional equity requirements imposed by the new “financial reforms,” leaves them virtually penniless!! Government is the problem, not the solution.

One of my dearest and oldest friends owns a small music store. I’m always surprised to see him still in business with all the taxes he has to pay to the county, state and federal level. I know he’d be doing so much better if these taxes suddenly disappeared and he could slash prices and customers would be banging on his door to get in.

Everything Ms. Rugy has written here is true, and there’s even more. There are tons of regulations that fall on businesses small and large alike, such as the Consumer Product Safety Improvement Act (CPSIA). Everything from cribs and ATVs to Hannah Montana DVDs, ballpoint pens and handmade fabric teething toys falls under CPSIA’s stringent requirements for lead and phthalate testing. This is killing tiny microbusinesses like mine, and CPSC’s “solution” to this is to propose having a Small Business Ombudsman. Yes, ONE PERSON is going to stand astride the problem of trying to figure out what tests every granny making rag dolls in her basement has to have performed before she can sell them at the craft bazaar. Whether Granny can afford the tests? Not their problem.

At our house we call this a “vacuum to the butt” approach. I.e. to get someone to eat, put food in front of them and a vacuum to their butt. It’s gross but in just four words it captures this idea of approaching the problem from the wrong end, oversimplifying the nature of what’s between the two ends, and probably resulting in irreparable damage to the system.

You are asking this following adoption of a health bill that is 12 times the size of the Constitution, was stacked to nearly four feet in height, and contains enough NEW regulations that will cause just one company (MickeyDees) to cease insurance on over 30,00 employees. But, but then, you said quantatative evidence, as if you were actually serious. My bad here.

A few months ago, Ed Schultz (fighting Lawrence O’Donnell for spot number 3 on the MSNBC hierachy) ran a segment where he blamed high unemployment on businesses intentionally not hiring to hurt Obama’s reelection chances. He brought some twenty-something blogger on who complemented his marvelous insight. Their conclusion falls perfectly in line with customary liberal thought: when all else fails, every one else is to blame.

This is a symptom of dictatorship thinking. Schultz and the N.Y. Times think everything that people do has some relationship to the king. If people hire more workers, it’s because they are being obedient. If they don’t they are being rebellious. With no consideration for what people would do(and are doing)on their own, toward their own individual goals.

Obama himself seems to think that if his policies aren’t working, it’s because he didin’t convey them well enough. Like he’s giving instructions to reality itself and if reality and his wishes fail to align, it must not have been a good enough speech.

A few months ago, Ed Schultz (fighting Lawrence O’Donnell for spot number 3 on the MSNBC hierachy) ran a segment where he blamed high unemployment on businesses intentionally not hiring to hurt Obama’s reelection chances.

Tax and regulatory policy will always be difficult. There are some simple principles that would really help, but our political class simply refuses to acknowledge them.

First and foremost, taxes should be at low rates on a broad base, to minimize distortions. But politicians thrive on high rates with a base narrowed by special deals, with the deals being paid for in various ways, by people who want to create distortions. Then others can argue “unfair” and pay to counter the first group with new breaks of their own. This problem is of long-standing and is systemic with both parties.

As for “uncertainty,” the problem is not uncertainty, per se, it is that all the uncertainty or risk is on the downside. If the uncertainty was whether the Bush tax cuts will be maintained versus keeping those cuts and in addition maybe instituting reforms that would reduce and reform the corporate income tax in line with other OECD countries, you would (I wager) see a lot of businesses consider investing just because they knew the tax regime would not get worse come January 1. The uncertainty about further reforms would still leave some projects marginal and on hold, but it’s a whole different game than what we are in, now.

In the current political environment, any firm would have to be crazy to take on loads of debt, and even crazier to go forward with investments that would entail hiring additional people. One thing the Administration has proved beyond a shadow of a doubt is that they are objectively (if unknowingly) determined to make it uneconomic to hire people into marginal jobs, and they have raised the bar on what is “marginal.” Not just ObamaCare, but could you imagine a worse time to raise the minimum wage and threaten to tip the NLRA balance against employers, than during a major economic contraction?

The people hurt the worst: minorities and young labor-force entrants–a big part of Obama’s core support in 2008. Poetic, I guess, but still painful to see.

The other thing many people fail to understand is the degree that “small” business is dependent on orders from “big” business. For example, in St. Louis there are many small companies that get major portions of their revenues from Boeing. Without Boeing, they are dead. While I don’t have hard data, I suspect that this is true across the country and economy.

I am a small business owner and de Rugy is exactly right. If sales are slow, there is no need to hire more employees. If Dems increase taxes for “those earning over $250,000,” I will have to let one of my employees go even tho’ I haven’t drawn a salary since 2009!! Amid all this, the government wants me to “grow” our business by offering low cost loans?? The answer is obvious, government expeditures COST the private sector. Reduce government spending and the private sector will recover on its own. The “stimulus” was Democrats simply breaking the piggy bank, rewarding their friends (unions and Wall Street) and punishing their enemies (business).

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Everything Ms. Rugy has written here is true, and there’s even more. There are tons of regulations that fall on businesses small and large alike, such as the Consumer Product Safety Improvement Act (CPSIA). Everything from cribs and ATVs to Hannah Montana DVDs, ballpoint pens and handmade fabric teething toys falls under CPSIA’s stringent requirements for lead and phthalate testing. This is killing tiny microbusinesses like mine, and CPSC’s “solution” to this is to propose having a Small Business Ombudsman. Yes, ???? ?????? ????? ??????? ONE PERSON is going to stand astride the problem of trying to figure out what tests every granny making rag dolls in her basement has to have performed before she can sell them at the craft bazaar. Whether Granny can afford the tests? Not their problem.